by T. GormanPosted on Posted in SECActions

Suspicion abounds when trading picks up in advance of an announcement, particularly if it turns out to be a significant one.  Sometimes the market-monitoring computers of the regulators signal possible anomalies, triggering an initial inquiry into “suspicious” trading to determine if there was illegal activity, such as, insider trading.  Sometimes a flurry of trading generates a lot of finger pointing and head nodding coupled with suggestions that “it must have been” illegal insider trading.  Sometimes it might be a sign of illegal activity.  Other times it might just be the sign of a healthy market. 

Bloomberg.com reported on “suspicious” trading activity in advance of the announcement by Rupert Murdoch’s News Corp. of an unsolicited $5 billion bid to buy Dow Jones & Co. for $60 per share.  http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aukny7sOH5d0 The announcement sent the stock of Dow Jones zooming up about 55% to $57.77, its biggest gain in months.  What was more interesting than the post-announcement trading, however, was the activity in the options markets prior to Mr. Murdoch’s blockbuster bid.  There, trading in options to buy shares of Dow Jones reached an 18-month high suggesting, according to the article, that “word of the . . .bid for the company may have leaked in advance” of the announcement.  The article continues quoting various sources who suggest that something untoward must have happened. 

Indeed, it might have.  As the Bloomberg article notes, just a few months ago the SEC brought an enforcement action and obtained an asset freeze following an investigation which begin with a similar trading pattern in TXU options.  That trading was in advance of a major announcement and the investigation turned up what the SEC says was insider trading. 

We have yet to see what happened prior to the announcement by News Corp.  But before everyone suggests that those option traders were doing something wrong, it is good to remember that the trading may well have resulted from good old fashioned work.  Every proposed deal like this one is worked on by dozens of people.  Those include executives at the company, outside lawyers, accountants, investment bankers, public relations specialists and a host of other people.  All of those people are brought “over-the-wall” and know about the proposed bid as it is put together in the days and weeks prior to its announcement.  It is not untypical for those people to participate in numerous meetings, phone calls, write documents and take other necessary steps.  Frequently they are working long hours.  Those around them including family, friends and others frequently see this increased activity.  Market professionals who watch companies and high profile executives such as Mr. Murdoch for clues to future activity often note the increase in activity – but do not know for certain what is being done.  

The bits and pieces of information gleaned from such observations are hardly material information – they do not tell the observer about the proposed bid.  Together with other public information, however, those bits and pieces can help traders make decisions about whether to buy and sell.  This activity, called “leakage” by economists, helps make the markets more efficient.  The more efficient the markets are the better the price – something that benefits everyone.  When the increased trading results from this type of activity, not only is it not “suspicious” or illegal, but rather it is beneficial to the markets and all traders. 

This theory is hardly new.  (see blog post 8/29/06)  In the late 1980s, then SEC Chief Economist Gregg Jarrell studied data on trading in advance of announcements based on information accumulated by the agency.  In his paper on this study now Professor Jerrell (University of Rochester) concluded that one cannot draw conclusions about insider trading from surges in trading activity prior to the announcement of a significant event.  While the trading might represent something suspicious, it may also be something beneficial to the markets. See Gregg A. Jarrell & Annette B. Poulsen, Stock Trading before the Announcement of Tender Offers: Insider Trading or Market Anticipation?, Journal of Law, Economics and Organization, vol. 5(2), at 225-48 (1989); Gregg A. Jarrell & John Pound, Hostile Takeovers and the Regulatory Dilemma: Twenty-Five Years of Debate, The Midland Corporate Finance Journal, 5 (2) (Summer 1987). Other economists have confirmed this work. 

All of this is to say that before we point the finger at those who trade just before an announcement by Mr. Murdoch we should take care to examine all of the facts.  Those traders may just have worked a little harder than the rest of us.  Those traders may also be doing us all a service by contributing to the efficiency of our capital markets. 

by T. GormanPosted on Posted in SECActions

Last week the SEC brought a long awaited action based on its investigation into the backdating practices at Apple.  SEC v. Nancy R. Heinen and Fred D. Anderson, Case No. 07-2214-HRL (Lloyd) (N.D. Cal. filed April 24, 2007) http://sec.gov/litigation/litreleases/2007/lr20086.htm  (see blog post of 4/25/07).  As discussed earlier here, the case added some definition to what standard prosecutors may use when exercising their broad discretion to charge.  Those cases suggest that future cases will focus on allegations of false documents and a cover-up – the kind of acts that support scienter – and situations where defendants have been directly involved in the issuance of the backdated options.  The company and those outside the options issuance process do not appear to be the focus of the inquiries.   

Yet, while most struggle to grasp where the SEC is headed with its options investigations, yesterday the Financial Times reported a new wrinkle that raises concerns for companies and their executives caught up in the on-going options saga.  Guerrera, Masters and Pimlott, “Threat to US Backdating Scandal Companies,” FT (Apr. 30, 2007).  The article reports that during a time when “cash-rich hedge funds and private equity groups are scouring the market for takeover targets” more than 40 companies are exposed to takeover bids because they have not filed financials with the SEC nor had a shareholder meeting for 13 months.  Under certain state laws, including Delaware, if a company does not hold a shareholder meeting for 13 months, investors can ask a court to call one.  Companies however are prohibited from issuing proxy documents if they have not produced up-to-date financial statements.  This inability to communicate with shareholders paves the way for activist investors to make proposals, such as removing directors, and the company would be unable fully to respond.  The article noted that Comverse asked the SEC to waive the ban on shareholder communications if the circling hedge fund succeeds in calling a meeting.  The SEC declined to comment.  Again, the question is where will the SEC take the option scandal on this issue.   

Curiously, this is not the first time that the media has reported new studies which may have contributed to the contour of the option scandal.  The current SEC and DOJ investigations into the backdating of stock options began with news articles, primarily those in the Wall Street Journal, which recently won awards for its coverage.  This year news articles have continued and more studies have been completed regarding the breadth of the option issue, including a study suggesting  that interlocking boards contributed to the backdating practice.  See Bizjak , John M., Lemmon, Michael L. and Whitby, Ryan J., “Option Backdating and Board Interlocks” (November 2006). Available at SSRN: http://ssrn.com/abstract=946787.  A discussion of the report is contained in the New York Times, January 21, 2007 at BU-5 (see post of 1/22/07).  Sometimes its difficult to determine if the regulators or the investigating media are driving this scandal.  (see post of 10/10/06). 

Now however the final chapter may be about to unfold taking another turn as it does so.  Last week Reuters reported that SEC Chairman Christopher Cox expects to wrap up many of its stock options dating cases within weeks. “We are working on procedures to move many of the cases very quickly,” Cox said, adding their resolution would be within “weeks.”  Rueters reported that Mr. Cox gave no indication of whether the options cases would be resolved through settlements, lawsuits or a combination of both.  Mr. Cox added that the SEC would like to put the option backdating scandal behind them, noting that such conduct will not likely continue in today’s environment.   Mr. Cox did not elaborate on what process the SEC is likely to use. 

The statements of Chairman Cox in the context of over 140 on-going investigations and the handful of cases that have been brought are curious at best.  While the scandal seems to ebb and turn in various directions, this newest wrinkle is perhaps the most intriguing.  On the one hand the Chairman’s remarks, read in the context of the cases brought to date could suggest that only a relative few of the 140 open investigations contain the kind of scienter laden allegations the SEC is looking for as the predicate for an enforcement action.  That would clearly be good news for many companies, their directors and executives.  On the other hand, the FT story may not be good news for the forty or so companies caught in that dilemma.  Yet, it is hard to imagine an enforcement agency like the SEC, which has been proceeding at an ever-increasingly slow pace, resolving 140 investigations in a matter of weeks.  Absent a new turn in the scandal, however, the Chairman’s comments do offer a view of the light at the end of the tunnel for many companies.